Growing wealth inequality is driven by one of three things – business income, labour income or housing income. Guess which one it is.

Okay, I know we’ve been spinning round the outer-reaches of the academic universe these last few weeks, but do you want an edge or not?

Do you want to see the trends that the big players see? Or do you want to keep taking your financial play book from the Sun Herald? See how far that gets you.

The whole point of these blogs is about helping you see a bigger picture. The higher up the mountain you go, the more you can see.

If you want gags and ramblings… well, that’s what Friday’s for.

So bear with me a little longer here. I’m building to something. I need more than a few blogs to do it. Nothing worth having is easy. But trust me, it will all come together soon and you’re going to be amaa-aazed.

The economy is a bunch of relativities. Everything in relation to everything else. The usefulness of labour is falling, so the relative price of labour must fall. That’s another way of saying that the price of housing, relative to labour must rise.

And that’s what we’re seeing.

But let’s slap a little more nuance on this picture. Let me pop a little swan made of meringue on top here.

Ok, so typically economist divide the factors of production – the stuff that makes stuff – into three groups – Land, labour and capital (machinery, factories etc).

Since land is fixed, economists just tend to put it to one side and focus on labour and capital.

(I know, you’ve got to wonder what they’re thinking.)

And so Marx said all history is the history of class struggle, between labour and capital.

A few years ago, Thomas Picketty, that French economist wrote “Capital” – which argued that wealth inequality was getting worse because capital owners were able to capture more of the surplus, at the expense of their workers.

And in all of this, land is just the place where they grow cheese.

And you can kind of get why. Land is just dirt to most people. It kind of has no character, no personality. It’s not able to rise up against its oppressive overlords.

The battle between labour and capital on the other hand – oh boy is that a story. It’s a theatre for all the hopes and dreams of the working class, all the aspirations of our entrepreneurs and captains of industry.

Land just doesn’t care about any of that. And it will still be there once all the workers and managers and capital owners are dead.

So it gets written out of the story.

And so then you see charts like this one:

This is the share of total income going to workers and to capital owners (in the way of profits).

The argument that people make – people like Picketty – is that labour’s share is falling and that’s a bad thing. That means workers have less power. Businesses have more. And that’s one of the factors driving inequality.

And that might all be true, but it is missing a huge piece of the puzzle.

Land.

Recently I did come across one economist who tried to put land back in the picture. This chart comes from a young grad student at MIT. It breaks capital income (from the chart above) into capital AND land (rather than just lumping profits and land income in together.

Look at what happens:

This is for the developed world since 1948. You can see that since 1980 in particular, capital’s total income share has been growing. That’s Picketty’s story.

But look at why. It’s not that regular business profits have been growing – the non-housing share of capital income has been pretty much flat.

All of the growth since 1980 can be explained by the increase in housing income.

Let that sink in for a second. If the rich are getting richer, if income and wealth inequality are getting worse then it’s got nothing to do with businesses, it’s got everything to with housing, and the way the rich uses property as the number one way, to build, protect and transfer wealth across generations.

I know as a business owner it may sound like I’m talking my own book here, but a careful and measured analysis of the above, highlights that the balance of evidence suggests that, taken together, all you pinko-lefties should take your redistributive business taxes and shove them up your bum!

(Nah, just kidding. You’re great. I love ya.)

But the central idea is that this hasn’t been a golden age for capital. Technology hasn’t made it easier to exploit workers and earn super profits.

If anything, technology has made the game harder. Technology depreciates in value and usefulness incredibly quickly (anyone want to by my Iphone3?), and the digital market place has meant that disruption is coming at you from every which way.
No sooner do you have a great idea, than a dozen firms in China are ripping you off.

Think about what AirBnB did to the hotel industry, what Uber did to taxis, what Amazon is doing to retail.

This is no capitalist utopia.

So labour income is falling. Capital income is falling, or it’s on the way down. The relative price of these two must decline.

Relative to what?

Land.

(Gee, it’s like you’re not even listening sometimes.)

As I’ve said before, in an economy where everything is getting less and less real, where more and more activity is moving into the unlimited infinity of unrealness, the relative scarcity of real things, commodities and real estate, increases.

As their relative scarcity increases, so does their price.

We’re still in the middle of a commodity boom that continues to surprise, and the real estate boom…

S&P just downgraded the entire financial sector. The timing is suspicious, but I just can’t figure out who’s pulling the strings.

Ok, this is another story that really isn’t getting the air-time it deserves.

Effectively, S&P just downgraded the entire Australian financial sector. Yep. The entire Australian financial sector.

Effectively, they said that yes, actually, there is a property bubble. And that bubble is, in fact, dangerous. So much so that every Australian financial institution is more of a credit risk than they were before.

Yep. Every one.

Oh, but not the majors. No. The big four are too big too fail, the tax-payers have their back, so no worries there.

What’s more, the timing of this is really breath-taking. Just as the smaller banks were looking forward to a more even playing filed thanks to the big bank levy, bam, they’re hit with a ratings downgrade, making them even less competitive.

The Bank of Queensland CEO is pissed. Oh man.

And this almost certainly feeds through into the interest rates we’re looking at. For the 23 smaller banks affected, their cost of funds just got more expensive. What can they do? They’ve got to pass it on…

But the timing of all this really makes me think that there’s something going on behind the scenes that we just can’t see. I’m not sure what that is, but I have three theories.

But let’s recap in case you missed it because this story really isn’t getting the attention it deserves. So Standard and Poors (S&P) – a ratings agency which effectively tells people in the money market how credit-worthy other institutions are – has downgraded 23 financial intuitions in Australia.

They did it all in one go, effectively saying that an “increased risk of a sharp correction in property prices” was now a threat to the entire Australian financial system.

The “big four” banks, however, managed to escape a downgrade because S&P believes they are likely to receive “timely financial support from the Australian Government” if something happens to the property market.

But then, after going on about the dangers of a “sharp correction in prices” and “economic imbalances” they do admit (so far towards the end of the press release that it’s practically a footnote), that actually, the “outlook for Australian banks remains relatively benign by global standards”.

So like, worry, but don’t worry too much.

It really is bizarre.

This isn’t about any institution in particular. Effectively they’re saying the entire Australian financial system is now a riskier prospect…

… because why?

What do we know now that we didn’t know at the beginning of the year?

They don’t point the finger at anything in particular. If something passed some sort of threshold to trigger a downgrade, they don’t say what it was.

And given everything else that’s going on in the past couple of weeks – with the bank levy and APRA’s second round of intervention, it just looks a little suspicious to me.

But I don’t know where to point the finger…

I’ve got three theories.

Theory One: It was the Big Banks

This is the most seductive theory. Effectively the big banks are so annoyed that the government turned around and stabbed them in the back with the Bank Levy, that they went out and had a quiet word to their mates/puppets at S&P.

As I said last week, I expected the big banks to come up with something big, and quickly. They have to hit back. They need to send a strong message, otherwise the Bank Levy could just go up and up and up.

Getting the entire financial system downgraded is a pretty strong message. Especially, when you get off scott-free yourself.

How do you like those apples, Morrison?

Theory Two: It was the government

At the same time though, this whole fiasco just focuses everyone’s attention on the reality that there’s one set of rules for the Big Four, and another for everyone else.

One of the best rationales for the Bank Levy was to claw back some of the funding advantages the Big Four got from their implicit government guarantee.

I don’t think most people understand just what a free kick this is.

So perhaps the government had a word to their mates/puppets at S&P and said, look, we need something that shows just how sweet the Big Four have it. If you wanted to downgrade all the minors, we won’t get in your way.

And so far the government has been surprisingly quiet. It is the kind of thing you’d normally expect to generate a lot of outrage.

S&P also downgraded China last week and the government there said that S&P had no idea how the Chinese economy actually worked.

But there’s nothing but crickets in Canberra.

Theory Three: It was the RBA and APRA

Another theory that holds as much weight in my mind is that it was the RBA and APRA.

So far this year there’s been a real shift in the tone of our regulators’ public statements. When it comes to housing, they’re suddenly talking tough.

Effectively, the RBA and APRA seem keen to “talk their way out of the problem”.

This is a classic play for the RBA. Remember 2003 when they started fretting about the “Sydney bubble”. A few warnings and a couple or rate hikes successfully took the heat out of that market, and things settled down.

We’re seeing the same strategy in action now. Rates are on the rise through APRA restrictions, and there’s a lot of jaw-boning going on. They’re successfully reshaping expectations.

The S&P downgrade fits perfectly into the narrative they’re trying to create. Economic imbalances have built up, and things need to be unwound in an orderly way.
So maybe the RBA and APRA had a word to their mates/puppets at S&P and said, look guys, a downgrade would really help us out right now – just a little one, just a little shot across the bows.

But which is it?

All of these scenarios seem plausible to me. But really, there’s no way to know. What do you think?

But at the end of the day, the least likely scenario in my mind, is that an independent ratings agency just decided to downgrade the entire financial system of an advanced economy, right in the middle of one of the most electrically charged political and economic climates in recent memory.

The brain works on a use-it-or-lose-it basis. Happiness is no exception.

“I’ve forgotten how to be happy.”

She said it like it was meant to be a joke, but she wasn’t laughing. And it wasn’t really funny. It kind of gave me chills.

I kinda got the joke she was trying to make. “I’m so tough and hardened that I’ve forgotten how to be happy, even though happiness isn’t something you do, like driving a car, and is therefore not something that you can ‘forget’.”

Boom tish.

Only thing was it kinda was like she had forgotten how to be happy. She had one of those mouths that seemed to have hardened into a frown. Like how some models have what they call “resting bitch face”. She had ‘resting general disaffection with life face.’

And she was very slow to crack a smile. In fact, the only time I remember her smiling or laughing, it was at the misfortune of others. If something went wrong for someone – or if something embarrassing happened to them – then it was like this wave of relief washed over her and she broke into laughter.

Actually it was more like a cackle.

And look, I don’t want to be mean. I know where her outlook came from. She hadn’t had the easiest life, and she’d never had a lot of self-confidence. So I can understand. I can empathise.

But it just struck me because I really think she had forgotten how to be happy. Happiness had become such an alien state of being to her, that she had lost the map to get back there.

And again, I think there’s this misperception about where emotions come from. We tend to think that our emotions are naturally set to neutral, and then we swing from happiness to sadness depending on what happens to us.

Like, you’re in a room having a rest. Your emotions are at neutral. Then someone comes in and gives you a foot rub for 5 minutes. You emotion-metre swings over to happiness. After they leave, and after a while, your emotions return to their neutral setting.

It’s like a pot of water. The water is at room temperature. Add heat and the water gets hot. And cold and the water gets colder. But take heat and cold away and the water naturally returns to room temperature.

This really isn’t the right way to think about it when it comes to happiness, and this framework gives away a lot of our power.

There is no neutral emotional state. Sure, there is something that is neither happy nor sad, but this isn’t like room-temperature. You don’t revert to it. It just happens to lie in the middle.

You’re natural tendency is just where you happen to spend the most time. We are creatures of habit. If you’re happy a lot, you tend to be happy. If you’re sad a lot you tend to be sad.

And what the whole theory of neuro-plasticity tells us is, that if you’re not using certain parts of your brain, those parts will be co-opted to serve other functions. It’s an efficiency thing.

So if you’re not using the part of the brain that is happiness, that part will be asked to chip in elsewhere – probably towards feeling more nuanced sadness if that’s where you spend all your time.

After a while, after your happiness cortex is subsumed by your sadness cortex (not actually things), it is actually very difficult to feel happiness at all.

You can, literally, forget how to be happy.

But if it is possible to forget, then it is also possible to remember.

And so at the risk of making every blog about radical self-reliance, there’s a lesson here.

Happiness is not a reaction to the outside world. Don’t think of it like that. Rather, think of it like a skill. It is something you do, like driving a car, and it is something you get better at with practice.

And if you’re serious about being happy, then put the time into it. Make space in your life and in your mind to feel happiness. Work on getting better at feeling happy. Come up with exercises for yourself to do. I don’t know, something like:

List ten things that make you happy.

What was the happiest moment in you life? What did it feel like?

Who makes you happiest? What does it feel like to be with them?

What are the physical sensations associated with happiness?

Fake it. Let me know, non-verbally, that you’re the happiest person alive. What is you’re body doing? Give it permission to do more of that.

I’m sure I could come up with more but I don’t think I need to. You know yourself best. You know what will work for you.

Now I know this might all sound a little twee and silly. And it totally is. If I went back 20,000 years and told my ancestors cuddling with their family around a fire, eating mammoth steaks and singing songs, that they should practice being happy, they would think I was an idiot.

But the reality is that we live in an era where our problem-solving minds are constantly being challenged. We can end up stuck in problem-mode. And this crowds out the space for being happy.
So we can forget how to be happy, not because we spend all our time being sad, but simply because we spend all our time being busy.

I’m not going to make any friends with this – probably lose a few in fact.

I’ve never been shy about making enemies before. If you want to bake a cake you need to break few eggs.

But enemies with serious money behind them? That’s another thing. And if we’re talking about a lot of enemies with a lot of money..? Well, then its time to review your security systems.

I’ve been sitting on this report for a little while. Some people in my team were pushing me to publish earlier. Some of them wanted to can it altogether. I almost pulled the plug on it a few times.

But I’ve decided to come clean.

In this report I’m going to blow the lid on one of the greatest scams of the century so far.

I’m going to show you how ordinary investors have been played in order to protect the interests of the rich elite. Like pawns, their financial futures were sacrificed to line the pockets of people who had already made their money.

Truth be told, people like me.

I’ve been awake to this scam since the get go – which is one of the reasons I’ve been able to do as well as I’ve done. But I’ve never stood up publicly against it before.

You do what you can do. You make sure your friends and family aren’t falling into the trap. You invest in education programs that give people real alternatives. But it is a scam so entrenched, so protected by power, that I felt I was helpless against it. What can one man do?

And so I did nothing.

But that was then. Now, I’m sick and tired of seeing people being taken for a ride, year after year. And now that I’ve developed a voice as one of the most widely-read property bloggers in the country, I feel a responsibility to use that position for the greater good.

I’ve found a voice and I’m going to use it.

And it starts with this report.

I’m going to show you just how the scam works. I’m going to show you who wins and who just gets played. And I’m going to show you just what you can do to keep yourself from becoming another victim.

So, what am I talking about?

NEGATIVE GEARING

The greatest trick the devil ever pulled…

Now I can hear the cries already. “What’s wrong with negative gearing?” “It’s income tax 101” etc. etc.

And personally, I’m not against negative gearing. I’ve used it a lot myself.

But this is the real genius of this scam. It’s impossible to talk about without talking about negative gearing, but negative gearing is not really the problem.

It’s just the tip of the iceberg.

And because of the way negative gearing works and its role – effectively making mum and dad investors feel ok about carrying loss-making properties – it has become a very energised topic. And the vested interests that benefit most have worked hard to make sure that it stays an energised topic.

And in all that energy and hoo-ha around negative gearing, they’ve managed to distract the country from the real issues involved.

Take the 2016 Federal Election. Negative gearing was one of the hottest of the hot-button topics. But it a total pantomime. Labor decided to propose negative gearing reform to differentiate themselves from the Coalition. Turnbull and Morrison also wanted to reform the ‘excesses’ of negative gearing, but they were rolled in cabinet so the Coalition could attack Labor “with clean hands”[1].

As far as the rich and powerful are concerned, there’s no debate. The negative gearing “debate” is nothing orchestrated theatre. Nothing but smoke and mirrors.

But let’s take a little peep inside the magician’s box.

I’ll get to the actual mechanics of the scam in a moment, and show you just how Joe Public’s been taken for a ride. But to appreciate how beautiful the scam is, we need to step back and see it in context.

The Puzzle

Here’s a question for you. Have the past twenty years been good years for the Australian property market?

Unless you’ve just been born, you’ll know that the answer is a resounding ‘YES’. On a global and historical scale, the past twenty years have been one of the great bull runs of all time. House prices have effectively triple since 1986.

So there has never been a better time to be a property investor… ever… in the history of the world. All of this should have sparked a virtuous cycle of equity and leveraging power, and Long Island Ice Tea’s around the pool at sunset.

But it didn’t.

This is the great puzzle of our times. If these have been the best times to be a property investor in the history of humanity, why haven’t investors done better?

And by better, I mean, why haven’t they used these conditions to expand their portfolios, develop passive lifestyle income plays, and put their feet up?

What the data shows is that 95% of investors don’t get past two properties. Of those that do, most don’t do all that much better. Only 2% of investors get to four properties. And less than 1% (or 0.068% of the Australian population) become portfolio investors with 5 or more properties.

The question is why.

If these have been the best market conditions in history, why have 95% of investors not been able to get past two properties?

The answer?

Negative Gearing.

Everybody’s doing it…

I don’t think people realise how common negative gearing is.

Two-thirds of investors report an income loss on their investment properties. The average negatively geared investor loses $10,947 a year or $210.50 a week.

Many lose a lot more.

… and everybody’s getting screwed.

Negative Gearing was sold to investors as a “professional” play. Like one of those B.S stories at the car lots when you get to see the fleet manager to get a better deal. They see you coming from a mile off.

But investors thought they were playing with the big boys. It was a clever way to mess with the tax man, and that’s what rich people do, right? Therefore, if I’m messing with the tax man, I’m playing like a big boy.

You’re not playing like a big boy. You’re playing right into their hands.

I’ve written a lot over the years about why negative gearing is a dud strategy – about the way people underestimate the operating losses involved, or the way it leaves them exposed if something goes wrong – like someone losing an income, or banks increasing rates. So I won’t go into it that again. But it doesn’t really matter. Far and away my biggest gripe with negative gearing is just that it is a portfolio killer.

If all your properties are bleeding cash, at some point the banks are going to stop lending to you. You hit up against a serviceability ceiling. You can only lay so many negatively geared properties on your income’s shoulders.

(And looking at the data, my guess is that that number of properties is 2!)

And the truth is that macro-economic factors have done a lot to disguise how dangerous negative gearing is. With interest rates on a steady downward run and rents growing at a decent clip, negatively geared properties can become positively geared in a few years. And once they become positively geared you can start investing again.

But interest rates are getting tapped out and rental growth is stagnating, so I don’t think we can rely on those macro-economic tail-winds going forward.

That means investors are playing with fire. If our obsession with negative gearing continues, two-thirds of property investors are going to find themselves seriously exposed.

So this isn’t an argument about what’s good for the country, what’s good for the market, or what’s consistent with taxation code or any of that. This is only about whether negative gearing is good for you – as an individual investor.

And the numbers speak for themselves. Through one of the great property bull runs in history, 95% of investors couldn’t get past two properties.

So that raises the question. If it’s not serving individual investors, who is it serving?

The CGT tango

This is where my accountant becomes one of those enemies I was talking about.

To understand how the scam works in practice, we need to understand how negative gearing works with the Capital Gains Tax discount.

As I said, negative gearing is not really the issue. We’re just made to think it is.

I think this stuff is dense and boring by design. It’s difficult to penetrate, which is why it has survived so long. But I’ll try keep it as simple as I can.

The 50% CGT discount was introduced by the Howard Government in 1999, and it was what allowed negative gearing to be used as a “sheltering tax haven” (in the words of Malcolm Turnbull, back when he was a back-bencher and could say what he liked.)

The drop off

The basic idea is that you arrange your affairs so an individual property is making a loss. You claim the loss against your income, which saves you 45 cents in the dollar, and ideally, drops you down into a lower tax bracket.

The pick up

You get your money back when the property appreciates in value and you sell it. The 50% CGT discount effectively means you’re only pay tax on half of the gain. That’s another way of saying you’re only paying half of the tax (half of your marginal tax rate) on the full gain.

The net result? If you play your cards right, you’ve paid half as much tax on that portion of your income than you otherwise would have. Nice.

I’ve used this strategy more than a few times myself.

Now you might think there’s nothing wrong with this, since the option is open to everyone. But the reality is that the negative gearing / CGT tango is a lot easier to pull off if you have deep pockets.

You have much more scope to arrange your affairs in the right way. You can wear rental losses for a long time and your not going to get caught out by market movements. Deep pockets and a large portfolio of properties means you can set up the right financing arrangements, and you also have more flexibility around when you enter and exit your trades.

There’s a lot to this, and I usually leave all this to my accountant, but if you want an idea of how well the NG/CGT tango serves the rich, have a look at these charts here.

We know that a higher portion of negative gearing losses, and negatively geared taxpayers occur at higher taxable income levels:

However, this is taxable income, so it is after negative gearing deductions have been included (which are often only there to reduce taxable income in the first place). So this muddies this picture.

We also know that higher income earners have much higher negative gearing losses. As I said before, the average loss is about $10,000 a year. But the average loss for people earning more than a million dollars a year is over $45,000.

It certainly looks suspicious. But you know, maybe if you’re earning a million a year you have more properties, or fancier tastes.

The crux of it is here – the distribution of Capital Gains Tax discounts. Almost three-quarters of the CGT discount benefits go to the top 10% of income earners.

So negative gearing is skewed, but the CGT discounts are off the hook! The capital gains tax discount overwhelming favours the rich – and I mean the very rich.

Rich people like me.

So the NG/CGT tango is a tax dodge for the rich. Pure and simple. At last count, it cost the country over $13 billion in lost taxation revenue.

That’s serious coin.

And every time this comes up, the same old lines get trotted out – that negative gearing mostly used by mums and dads and “ordinary” investors – policemen and nurses and so on.

But which electorate do you reckon uses negative gearing the most?

Wentworth.

Yep, Malcolm Turnbull’s plumb electorate in the Eastern Suburbs of Sydney. The last time I was sitting in a café in Vaucluse, overlooking the sunny harbour, drinking an $18 a glass chardonnay, I wasn’t thinking, yep, Battler Heartland.

Here’s a bonus thought for you. Every state and territory in Australia reports an average rental loss at the moment. But where is the biggest average loss?

Canberra.

Do those politicians know something we don’t?

Getting played like a fiddle

And that’s the thing about the negative gearing debate. So long as there’s a negative gearing debate, there can’t be a CGT discount debate. But the negative gearing ‘debate’ is so energised and noisy, that we never get to the crux of the issue.

Genius.

At the same time, the rich elite have mobilised an army of mum and dad investors to defend their interests for them. If you’ve got a negatively geared property, you are deeply invested in the negative gearing regime. If negative gearing goes, all you’ve got is a property bleeding you of cash.

No one wants that.

And so even though the benefits of the NG/CGT tango overwhelmingly go to the rich, and even though negative gearing has hamstrung a generation of investors, the most vocal defenders of the system are the ones the system is failing to serve. (Isn’t it always the way?)

I’ll let you in on a secret. None of this was an accident.

You’re getting played like a fiddle.

Armed with paper swords

One of the amazing things about this campaign to protect the NG/CGT tango is the amount of misinformation out there. Here’s a couple of myths:

Negative Gearing helps bring Supply to the market

The truth is that 93% of investors buy existing properties. Only 7% buy new properties that increase the housing stock – owner-occupiers do much more heavy lifting here.

Removing Negative Gearing will cause House Prices to Fall

This is inconsistent with the first claim, but it doesn’t stop people trotting them out in the same breath. If the first is true, then removing negative gearing should reduce housing supply, and prices should actually rise.

But the first isn’t true, and it seems negative gearing does little for supply. That means it should have little impact on prices… or rents…

Rents soared last time we removed negative gearing

This is one of the most popular myths, and refers to the time Labor removed negative gearing between 1985-1987.

The truth of it is that it was a mixed bag across the states during this time. Rents rose in Sydney and Perth, but fell in every other capital city, leaving the national market flat over all.

If negative gearing had any impact on rents, it certainly wasn’t consistent from city to city, and you can’t see it here in the data.

But if it wasn’t about the so called ‘landlord strike’, why did Labor reinstate it after just two years..?

… Remember those powerful vested interests I was talking about?

Shit is getting serious…

So it might be tempting to say, so the rich are screwing the poor. That always happens. At least no one got hurt.

And that’s true to an extent.

But from where I stand, I see a generation of investors who never found a way to make property work – who never made it a vehicle for true financial freedom.

In my eyes, that’s a crime.

What’s more, the system has enjoyed a lot of cover from the macro-economics over recent years. Interest rates were falling, rents were rising. That made the negative gearing strategy look a lot better than it actually is.

But a lot of that cover is evaporating.

Take interest rates. Interest rates have fallen steadily over the past decade or so, to a 50 year low. But they can’t go all that much further. As a small open economy we can’t go to zero like the big boys, so that means rates could fall another 1 to 1.5 percentage points at most, and that’s even if they do fall.

Once you’ve hit rock bottom, there’s only one way rates can go: up. That means there’s going to be very little help for negatively geared properties in the years ahead.

Or take rents. In a low interest rate environment – the yield on assets is also low, since the first is a foundation for the second. We’re seeing that with rental yields, that have also fallen to historical lows in recent years.

This is keeping downward pressure on rental growth. That leaves wages growth to do the heavy lifting in driving rents, but wages are going nowhere.

And so rental growth has been falling since the GFC. In fact, in the detached housing market, rental growth has recently turned negative for the first time since records began.

Rents are already falling.

This has serious implications for a negative gearing strategy. If interest rates hold, and rents go nowhere, then a negatively geared property remains negatively geared… indefinitely. It’s negatively geared til one of those things improves.

So for the time being, that means investors can’t rely on macro-economic forces turning their negatively geared duds into positively geared cashflow performers.

But even that’s a reasonably sunny scenario. Imagine if rates rise (only direction they can really go, though not likely in the short term) or if rents fall (they are already in some places!). That means your negatively geared property starts bleeding more cash. And then more cash. And then more and more cash the more rents fall.

How long can you support it? The rich folks will be alright. They’ll just ride it out or rearrange their affairs. But how long can you keep it up? You’re bleeding from a wound that doesn’t want to heal.

If this report can save you from that fate, then it will have done its job.

A hard truth

So this is the truth about negative gearing. It’s the story of ordinary investors being mobilised to defend a system designed by the rich to benefit the rich.

That said, I sincerely hope that you will be rich one day too.

Then, I think you’ll find negative gearing to be a useful strategy. When you’re in the payout phase of your portfolio, when you have a number or properties and the flexibility to arrange your own affairs, you will probably find that negative gearing is a good way to optimise your tax.

Which is exactly what I have found.

But don’t jump the gun. If you’re still in the construction phase of your portfolio – if you are still acquiring properties and establishing income streams to give you a bit of distance from the 9 to 5, then stay the hell away from negative gearing.

Negative gearing was not designed to serve you. In fact, it was designed to make investors nervous about their position and more easily mobilised into political action.

Now I totally get it if all this just makes you want to throw up your hands and walk away.

And I also understand if this report makes you angry – if it makes you want to get active and start campaigning for political change. I’m telling you, you’re going up against some powerful vested interests and change isn’t going to come easily. But sure, if you want to send a copy of this report to your local MP, go for it.

But first things first. Protect yourself and protect your family.

Because negative gearing isn’t the real villain here. Ignorance is.

But now you know how the system works. Now you can game the system for yourself. From where I sit, the tide seems to be shifting. Public opinion is divided. This report will get out there.

There’s a growing mood for change.

So there’s a window of opportunity here. If you’re in the construction phase of your portfolio and you have negatively geared properties, time to start transitioning away – consider strategies that can increase the rental return on your properties.

And for a short time, you still have cover from those investors who don’t know what a scam negative gearing is. They’ll figure it out eventually, and I’m doing my bit to tell them, but in the meantime they’ll keep chasing properties with atrocious yields.

The more that leaves for savvy buyers like us.

We also have some sophisticated strategies for building cashflow and equity – the stuff that really makes you money. Stay tuned to Knowledge Source for that.

But now you are warned. And now you are armed.

Ignorance is the real villain here. Don’t fall into its trap.

Wishing you all the best with your investing career, whatever shape it takes.

In my last post I outlined the reasons why I thought 2014 was going to be a big year, and house prices were on track for some impressive growth.

Now every time I say something like this, people look at me sceptically. Houses are already so expensive. How can they go higher??

How can they go higher, unless there’s a bubble??

First of all, there’s a lot of people who claim Aussie property has gone bubble. But just because something’s expensive doesn’t mean there’s a bubble. BMWs are expensive, but that doesn’t mean there’s a bubble in BMWs.

And if you look around at what’s going on overseas, it doesn’t look like there’s a bubble here – even in super-charged Sydney.

Take a look at this chart here, from ANZ. This looks at house prices in a number of major cities around the world.

What it shows is that price increases in Sydney have been relatively tame. We’re certainly no Shanghai! We’re not even a London or Toronto.

So if someone tells you that Sydney property (let alone the other capitals) is in a bubble and it’s about to burst, tell them you might believe them once the bubbles in Shanghai, Hong Kong, Toronto, Singapore and London have burst first. Until then, it’s not something to worry about.

But price is a really simplistic guide to spotting a bubble. And not that helpful. As I said, just because something is expensive, doesn’t mean there’s a bubble. We’ve got to dig down past simple price movements, and look at what’s going on at the most fundamental levels – supply and demand.

So the first question we need to ask ourselves is, is there enough demand to support prices at the current level?

Another way to get at this is to ask the question, can people afford the houses that are on the market now.

This is getting at the idea of ‘affordability’ and it’s fundamentally important.

There’s a few ways I’ve seen to cut this up, but none of them are telling us that house prices are out of reach and that there might be a bubble.

The first one I like comes from RP Data and HSBC. It looks at average house prices as a multiple of household incomes over the past 20 or so years.

What HSBC argue is that around the turn of the millennium there was a level shift in the house price multiple. Through the 90s is held around a consistent 2½ times income.

But after the turn of the millennium it took a step up. They argue that there were some fundamental changes to the market that caused that to happen. Interest rates fell and were held low, inflation expectations became contained, and there was easier access to credit.

This meant that people could afford to spend more on their houses, and they did. The multiple jumped up to 4.2 times. But people weren’t worse off. Because interest rates had fallen and incomes were rising, it effectively cost them about the same.

So the millennial jump had everything to do with a structural change in the market, and nothing to do with a bubble. That’s why it’s held steady at 4.2x since it made the jump.

ANZ also have a chart looking at affordability I find very evocative.

They calculate their own measure of household purchasing power. Basically they’re adjusting household income to account for prevailing interest rates. Then they compare that purchasing power to actual house prices:

What they show is that, right now, following five years of go-nowhere growth in house prices, and at the same time as incomes have been rising, actual purchasing power is now running far ahead of actual prices!

The implication is that prices are actually cheap right now. And since the 80s purchasing power and house prices have always come back into alignment, but it’s always prices that did the adjusting. Purchasing power tends to grow steadily.

To make it clear what that means, I’ve highlighted it here on this chart:

The last time we had a gap like this was back in 1998. The gap then was around $80,000. What we saw was that, over the next four years or so, prices made that gap up very quickly, and then some, until they finally caught up with purchasing power.

By the time they did, prices had risen over 50% in four years!

That’s the kind of gap we’re looking at now. There’s almost $100,000K difference at the moment. That gives you a feel for the kind of catch up we can expect… at a minimum.

But if incomes keep growing – and as I said in my last post, there’s every reason to think that they will – then the reunion point could be at a much higher price. Just eyeballing it, it looks like it could be around the $700,000 mark.

From current levels, that means about a 30% increase in just a few years!

So much for that bubble.

But is that really what we can expect? Sure demand is bumping along with rising incomes and foreign interest. But what’s happening to supply?

Well, as I’ve argued before, Australia is actually pretty crap at building houses. We’re just not building enough of them.

This chart here tells the story:

New home sales have been falling for the better part of a decade… and in a big way too. New home sales are down from around 160,000 a year at the beginning of the millennium, to about 80,000 now.

That’s a 50% decline!

So supply is lagging way, way behind. And so if demand is forging ahead, but supply is lagging behind, that’s got to be driving us towards a shortage.

And that’s exactly what we’re seeing.

This measure from CBA looks at the demand and supply balance. On their measure, we swung from surplus to shortage around the time of the GFC, and we’ve had a serious shortage since.

And shortages mean rising prices. But we haven’t seen that have we? No. Confidence has kept a tight lid on things.

But that just means we’ve got a lot of catching up to do! Prices are a tightly sprung coil.

So the take home message is this. No, there is no bubble. Aussie house prices don’t appear over inflated. In fact, looking at purchasing power, we should expect to see some big price increases in the years ahead. And looking at the supply / demand balance, huge shortages also imply that big price increases are on the cards.

Prices are being jacked up by both demand and supply. To my mind, 30% over the next couple of years would have to be the minimum.

But, there’s a massive lesson in this and I bring it all together in the finale.

Let’s jump straight in.

More evidence that the world’s gone mad…

Take a look at this jacket here. This is a Marmot Mammoth Parka. On the streets of New York (like I would know) it’s known as a biggie because of it’s baggy shape.

To start with, one of these retails for around US$680. Yep. That zero is supposed to be there. Now I haven’t spent a lot of time in cold climates, but is that a reasonable price to pay for a parka? Seems pretty over the top to me. Maybe it is lined with actual mammoth fur.

But with exclusivity comes desirability. And with that hype comes the news that people are now getting killed for their biggies in New York. Earlier in the month a teenage boy was shot at an ice-skating rink after refusing to give up his biggie. A 14-year-old boy was caught up in the mess and was shot in the back.

The senselessness of the tragedy is stupefying. Of all the things to die or kill for, how is a day-glo parka one of them? Seriously, duck down to Lowes (Department store in Sydney), you can pick up a Mr Big high-vis jacket for 20 bucks.

But this isn’t a new phenomenon. People have been killing people for sneakers since the 80s.

In June, a man tried to rob customers waiting in line for the new US$180 Lebron X Denim Sneakers. But prepared and ready, one of the customers pulled a gun and shot him.

Seriously. Look at these shoes.

Such ugly pieces of crap. If you paid me 180 bucks I still wouldn’t wear them, and definitely not if there’s a chance that I might get killed for them.

It’s tempting to write it all off as one of those crazy only-in-America things. But we did have kids robbing each other for shoes here too – though I don’t think anyone was ever killed.

Maybe it only becomes news in America because there are more guns on the street, and if you’re a disenfranchised minority, life is more desperate. It’s a bit more ‘kill or be killed’.

But I think it also shows us something universal about human nature… and highlights one of the traps on the road to wealth and financial freedom.

And that’s the trap of ‘status goods’.

Your definition of a status good differs on your life context. On the streets of New York its expensive jackets and sneakers.

In Australia it’s more likely to be that Mercedes Benz, a Rolex watch, a flashy house in a well-to-do suburb. If you’re a teenager, it could an I-phone or a particular brand of clothes.

We buy ‘status goods’ to make a statement. I am this kind of person. I have climbed this far up the social tree.

Remember the Seiko ad? “It’s not your car or your clothes… it’s your watch that says most about who you are.”

Buy the watch. Make the statement.

But there are three massive dangers in this kind of thinking.

The first is that status is a relative concept. Your relative position in the social tree requires that there be monkeys below you.

And so rocking out some kind of status good is the same as going around saying, “I’m better than you.”

That’s not very nice. And if this is the vibe you’re putting out into the world, what do you expect to see reflected back at you?

(Some guy with a hoody and a knife?)

No body likes to be the monkey at the bottom getting crapped on.

The other thing that comes with relativity is that your ‘status’ only lasts as long as it takes for everyone else to get what you’ve got. And so we all get locked into an endless treadmill of bigger, better, flashier.

But finally, and this is the real kicker, a concept of status is only compatible with a scarcity mentality.
Let me break that down. I’ve written before about the importance of having an abundance mentality. If you believe that there is limitless abundance in the world, then you will effortlessly welcome wealth into your own life, you will see and seize the opportunities when they arise, and most importantly, you will be generous and beautiful person. It’s the biggest wealth ‘secret’ I have to teach.

But it follows that if you have a scarcity mentality, then the opposite applies.

And a status good by definition is something you have that other people don’t have and can’t have. They can only exist in a world of lack and limit.

But if you believe that it’s true for the monkeys below you, then you must believe, even if only subconsciously (and this is the level that really matters) that it is true for yourself.

The world is limited and the wealth of one excludes the wealth of another.

This is a very, very dangerous idea. Give to much power to this and the road to financial freedom will become a long, fearful slog.

Most rich people I know don’t understand why everyone isn’t rich. They believe there are infinite opportunities to attract wealth into your life. They know the pie is endlessly expanding. And if someone makes a fortune, it doesn’t mean that there’s any less for them or anybody else.

And so they celebrate everybody’s success. And as I’ve said before, they don’t get into the flashy cars and bling. They don’t have a point to prove.

Now I’m not anti-consumerist. I love my things. But I love what my things do for me, not what they say about me.

There is only one truly sustainable source of love and respect and self-worth. And it’s definitely not status goods.

It’s ourselves.

Put the work into loving and accepting yourself, and you won’t be sold on the marketing drivel that watches can make you feel valuable and worthy.

And then you will be free to spend money on the things that really matter to you – your friends, your family and investing in your financial freedom.

It’s not something that a lot of people realise, but the road to wealth and financial security often demands a high-level of emotional intelligence.

Not always, of course. A lot of people make it into the upper echelons of wealth-dom without ever tuning into their own feelings. But for the kind of work that I do, and the kind of help that I offer people, a bit of emotional intelligence is essential.

For example, how do you feel about Paris Hilton?

When you think about all of her ‘obscene’ wealth – the cars, the jewellery, the Hollywood parties… when you remember that she’s never done a real day’s work in her life… when you realise that she commands more media attention than the Dalai Lama, but has less to contribute than a telletubby…

How do you feel about that?

If you’re like a lot of people I know, the emotional flavour tends to a sort of ‘condescending amusement.’

It’s a seductive emotional state. It makes you feel good. “I may not have a lot of respect, but at least I’m not that much of idiot. I may not have a lot of success, but at least I know the value of a hard day’s work. Maybe no-one cares about what I think, but at least I have opinions more sophisticated than a recipe for chocolate crackle.”

We live in an age where we are fully encouraged to give the dogs of judgement completely free rein. It’s the age of reality television (though I don’t know how much ‘reality’ there is in throwing a bunch of strangers into a completely contrived, studio-based situation…) But the primary commodity that reality television sells is ‘recreational judgement’.

We’re encouraged to sit around a bowl of pop-corn and have a good ‘ol judge.

“O.M.G she is such an idiot!”

“I can’t believe he just said that!”

“What is she doing? Who told her she could sing?”

And in case we’re missing the cue to flex our judgement muscles, put three authoritative ‘judges’ in some massive over-sized chairs, just to lead us through it.

(And then at the end, throw in some feel good, rags to riches, story of success we can all rally around and maintain the internal narrative that we are essential supportive and loving people – not completely lost to the demons of judgement and spite.)

But there’s a real danger in spending too long in this kind of space.

This is the lesson of ‘neuro-plasticity’. The more we practice something, the better we get at it – in all aspects of our life.

So if we spend a lot of time flexing our judgement muscles, they’ll get bigger. We’ll become judgment machines.

There’s a terrible danger in this, and I reckon society is completely blind to it.

Because the same muscles (neural pathways) we use to judge others, are exactly the same muscles we use to judge ourselves.

And so the more critical we become of others, the more critical we become of ourselves.

“judge not, lest ye be judged.”

And hating yourself is the surest path to unhappiness.

And the rub is that the more critical we are of ourselves, the more likely we are to being seduced by the recreational judgement of others. Paris Hilton is more of an idiot than me. That makes me feel good (well, less bad).

But it’s total mental junkfood, in that leaves you worse off in the long run. Because with the same thought that you’re judging Paris Hilton, you reaffirming the statement that you are also an idiot AND you’re building up your judgement muscles.

Don’t do it to yourself.

It’s a road to damaged and broken self-esteem. And it scares me that this is where we’re going as a society.

If there was a petition to ban reality (or recreational judgment) TV, I’d be the first to sign.

But I’m not in the business of lecturing psychology or social engineering. I’m in the business of helping my friends (and I consider every client a friend) find the road to financial security and wealth.

So let me say then that unchecked judgement will become a major barrier to achieving the wealth you’re after, if you’re not careful.

Why?

Because why are you really judging Paris? Do you hate people less intelligent or less educated than yourself? No, my bet is you generally have compassion for those less fortunate than yourself in the brainy stakes.

Or do you hate people who don’t work? (hang on, aren’t you here because you want to spend less time working for the man, and more time hanging with friends and family and doing what you want?)

Or do you hate people who are wealthy and successful? But again, isn’t that why you read these posts. (I’m sure it’s not for the dazzling writing or even the technically correct use of grammar and punctuation.)

Even if it’s only at a mild and modest level, can you see what happens if we set up that kind of contradiction within ourselves? If we aspire to wealth and success, but freely judge those who are wealthy and successful?

We are asking ourselves to become the kind of person we don’t like.
Why would we do that? We beat ourselves up enough already. Why would we want to take more of that kind of punishment on?

And so a subtle level (even a vibrational level if you want to get all new-agey about it) we’re creating a resistance to exactly the kind of story we’re trying to call down for ourselves.

And so we won’t call down the opportunities we need, or if they do come, we’ll be unable to act.

No, we have to be careful. We need to be fully at peace with the journey we’re asking life to take us on. We need to feel it out, and feel joyful and expansive about it.

It takes work. It takes emotional intelligence. And it takes powerful discernment.

I just wanted to follow up on a couple of the comments I got on my last post.

In that post, in cased you missed it (it was a cracker), I explained why I wasn’t buying gold.

I don’t think the price will go up, (more than likely will have further to fall from here) so I’m not a gold speculator. And I don’t really think gold at these prices will protect my wealth should there be some sort of economic calamity. I’m not a gold insurer.

And I’m not a gold investor, because gold doesn’t pay you any returns.

So I’m not buying gold.

Now, pretty much every time I run this line (in these blogs, at dinner parties, at committal hearings) people accuse me of having my head in the sand.

The system’s corrupt, our currencies are fantasies, a global meltdown in inevitable.

Winter is coming.

So first of all, let me make it clear that I’m not some profit/loss Pollyanna, skipping through sunlit fields of blue birds and butterflies.

I’m well aware that there are dozens of icebergs lurking in these waters. At any one time, there are dozens of roads that would take us to economic ruin town.

But will they?

Murphy’s Law doesn’t apply to economics. Just because something could go wrong, does NOT mean that it will go wrong.

I mean I could think of any number of scenarios that could lead to a house price bust from here.

Maybe for some reason the US banks decided to monetise their massive balance sheets. This leads to run away inflation in the US. The world’s reserve currency collapses, global trade shrivels up, Australia follows the rest of the world into depression.

Maybe the reform program in China comes off the rails, or the Chinese property bubble pops. Chinese demand shrinks, wiping out what’s left of the mining sector’s contribution to the Australian economy. Incomes fall, unemployment rises, and the collapse in housing demand leads to a ‘Steve Keen’ correction to prices.

Or maybe the Italians and Spaniards follow Greece into debt delinquency, the European Union collapses, Germany starts an “Occupy Rome” movement, and the following debt crisis paralyses global credit markets. Home lending at home freezes.

I’m not ignorant to the risks.

They’re all perfectly reasonable scenarios. All perfectly feasible. And if they did occur, future generations would wonder how we could have been so blind to the risks. Hindsight is 20/20.

But the question is not ‘could’ they happen? But ‘will’ they happen? Just because the trigger exists, doesn’t mean it will be pulled.

People have been talking about all sorts of economic boogeymen since before the dog was a pup – the break-away colony of America, the rise of fascism, communism, the departure from the gold standard.

Oh that last one was a classic. People were predicting that the new currency wouldn’t last five years. That gold was again the only way to store your value.

But that was over 40 years ago.

That’s not to say that there were no risks. There were risks. There still are. It just didn’t play out that way.

There are always things that could go wrong.

But I tend to think that a heightened level of risk is just the price you pay for living in a complex global economy. It’s like driving a sports car. If your top speed is 240km/hr, then there’s obviously a lot more that could go seriously wrong.

But that’s also the point.

Likewise, we live in an era of unprecedented leverage, trade and economic speed. There are more risks associated with such a system, but I for one wouldn’t be taking us back to the 1950s.

As much as I love Elvis.

The other argument I don’t get in all this is from all those people crippled by conspiracy theories.

The central banks are owned by space reptiles. The currency has no real value. The Illuminati pulls the strings of government. The whole financial system is about implode. Justin Beiber has genetically modified talent.

Again, I’m not saying I’m ignorant to the stories that are out there. And I certainly believe that if individuals found themselves with the ways and means to twist the fate of the planet to their own benefit, they would.

And there’s a lot of things about 9-11 and the GFC that make me very, very suspicious.

But what I don’t understand is why this is a reason to buy gold.

I mean, if there was going to be a market that the Illuminati would get their claws into first, surely it would be gold.

And according to the official figures (as much as you can believe them) the biggest holders of gold are the global central banks. They account for 18% of the gold ever mined. And 72% of that is held in the US (most of it belonging to foreign central banks).

(Just why does Bundesbank store their gold at Fort Knox?)

So what would the central banks do if the sh$t hit the fan? Would they resign themselves to the will of the market? I doubt it.

To me, gold seems like a very unlikely commodity to put your faith in. Particularly if you don’t actually have the gold sitting in your basement.

“Excuse me space reptile, but now that Armageddon is here I’d like to exchange this piece of paper for some shiny metal.”

But who knows what the actual truth is. I don’t. And if I did I’d probably be lock up in Guantanamo Bay.

But am I going to let this stop me from getting ahead in life?

No way!

You’ve just got to do the best you can with what you’ve got. Life’s just like that.

Maybe the game is rigged, but it’s still a game. And it’s a game that’s treated me very well up til now.

You can’t conscientiously object to the current economic system (which is not to say we couldn’t change it over time if we all worked on it). But for now, it’s all there is.

And so you’ve just got to do your best with what there is. Be the best person you can be. Invest your money as best you can. Be a loving friend and family member.

Choose to be an active investor. Not a side-line philosopher.

One last thing… Sometimes I read the comments on my blog and think, “Dude, we’re just not meant to be together.”

Oil and water don’t mix.

I don’t mind people disagreeing with me, I’m always happy to consider another view of the world. But if you vehementtly oppose my views, opinions and call me an idiot then I suggest you get off my bus and find yourself another one that’s a bit more to your philosophical views and likings.

This will surely create some controversy…. Add to that the conspiracy theories and certain stock market reports that use gold as the ultimate fear-axis to get attention, what you end up with is a lot of disillusioned and misled investors.

The only truth is the result.

If you only had one chart to wrap up what’s happening in global markets right now, it would be this one – The price of Gold.

Since a 2011 peak at around $1900 an ounce, the price of gold dipped… and then sank… and is now trading around $1300 an ounce, with every threat that it could be falling further.

That’s a 30% fall in less than two years.

The golden days of gold seem to have run their course. For a long while it could do no wrong, from a launching pad of around $250 an ounce before the turn of the millennium, it posted gains from pad to peak of over 600%.

And all this through the most ‘challenging’ of economic times – through the popping of the dot.com bubble, the Enron scandals, The Iraq wars, and even the GFC.

Gold was the thinking man’s safe haven of choice.

But not this year. Gold’s been on the skids since George Soros indicated in April that he thought that gold was no longer the safe haven it used to be, and the smart money was getting out. Then in October, Goldman Sachs’ head of commodities research said gold was a “slam dunk” sell and that it was headed for $1,050 an ounce.

(No, I don’t know what a ‘slam dunk’ sell is, but it sounds serious.)

But you still hear people saying that gold is a ‘safe investment’.

So let me spell it out loud and clear, in flashing neon lights…

GOLD IS NOT A SAFE INVESTMENT

First of all the idea that gold is ‘safe’ is ludicrous now. “Safe” investments are things like term deposits, that pay you a predictable amount of sod-all a year, with zero volatility.

“Safe” investments DO NOT fall by 30% in 18 months, or have volatile lurches in price every time Bernanke farts.

Secondly, as I’ve argued, gold is not really an ‘investment’. Not as I see it. Gold doesn’t pay you a return. There’s no rent or dividends.

If you’re buying gold, then you’re probably doing it for one of two reasons. The first is that you expect that the price will keep going up, and you’ll be able to sell it for more than you bought it. This isn’t gold investing, this is gold speculating.

But if you’re speculating then you’re completely at the mercy of the market. You’re “investment” is only worth as much as everyone thinks it’s worth, and if George Soros tells everyone that it’s not worth as much as they thought it was worth, then you take a hit.

The second reason people have bought gold, especially since the GFC and the launch of the Quantitative Easing era, is as a way to preserve wealth in the face of global economic calamity. If the economic system completely melts down, or even if we only have run away inflation, then gold offers you a way to preserve your wealth.

In this sense, it’s really just a shiny insurance policy.

But you know, I’ve never really understood this.

Let’s say a door-to-door sales comes to your house and offers to sell you zombie apocalypse insurance.

“If you pay us a certain fee, we promise to return your wealth to current levels, should there be a zombie apocalypse.”

There’s a few things you’ve got to ask yourself.

How did this guy get past the security gate?

How likely do I think a zombie apocalypse actually is?

If there is a zombie apocalypse, is this guy actually going to be able do what he’s promising? If the world is actually taken over by brain-eating zombies, who’s going to give me my pay-out? What will a pay-out even be worth if I don’t own a shot gun?

Now, when it comes to gold, I think most people get to 2., but never make it to 3.

What’s the risk of total economic melt down? I’d actually have to say to me, it looks like an incredibly small risk. Our standards of living are built on the foundations that the current economic system survives and prospers. Everyone wants to see the game continue – from the vested interests of Wall Street, to the mums and dads of back street Australia.

So a bet that the economic system will fail is to bet against the ingenuity and endeavour of the entire human population. I’ve seen humans do some pretty crazy and amazing stuff. For my money, if we had to find a way to avoid economic ruin, I reckon we could. We have the social, political and technological will.

But more to the point, if the economic system did collapse, what would a piece of paper that said you owned a chunk of gold in a basement in London actually be worth? Who’s going to honour it?
If there’s total economic collapse then no one’s paying the police. There’s a break down in the rule of law. Even if you had it in your hands, would some one give you their last can of beans for it, if there was no food to be found?

My point is, when people buy gold to insure themselves against economic collapse, they forget that a post-collapse world would be fundamentally and radically different, and if that is what they’re worried about, a piece of paper that says they own some fairly useless metal isn’t going to save them.

And before you say I’m missing the point that QE is debasing the USD, and inflation is inevitable… if that’s your argument, look at the inflation data. 5 years into QE inflation is falling not rising.

Who knows how it’s going to end? It’s radical stuff. But there is nothing to say that it has to end in hyper-inflation. If there was such a certainty, then it would have been priced into the market already.

Nope, the gold boom was a gold bubble. The further we get from economic calamity, the more it will unwind.

So if you want to speculate, buy something else. If you want insurance, buy a shot-gun and a bunker of canned food.

Let’s say I’m an eccentric millionaire (not such a stretch). I’m going to toss a coin. If it comes up heads, I pay you $7000. If it comes up tails, you pay me $4000.

Would you take it?

Would the prospect of winning 7 grand of my money be worth the prospect of losing 4 grand of your own money, when both have an equal chance of happening?

Would you do it?

Now, if you’re like most people, this bet simply just isn’t worth it.

I’m not saying ‘like most people’ because I’ve actually been out there roaming the streets trying to play odd gambles with strangers, like some cross between Willy Wonka and Donald Trump. Psychologists and economists have studied gambles like these (mostly in the abstract), and found that typically, people just don’t go for bets like these.

But why exactly don’t we like this bet? The ‘expected value of the bet is:

(50% x $7000)
+
(50% x -$4000)
= $1500

That is, it’s positive. The expected return of this gamble is positive. In economic theory, you’re taught that people like gambles like these. From a purely economic perspective, it’s a good bet.

But again, economics has given us something that is true in theory, but wrong in practice. So it’s over to the psychologists to come up with an explanation.

There’s a few related constructs that help explain this future of the mind, but central among them is a concept called ‘loss aversion’.

Studies show that losses loom much larger in our mental view of the world than similar sized gains.

Know the saying ‘a bird in the hand is worth two in the bush’? We value things we have much more (2x more according to that proverb) than things we don’t have, but could have.

And we’re hard-wired to hate losing things.

This can create some interesting quirks. What if I put on my Willy Wonka hat again and offered you a gamble that offered a 10% chance of winning $95, and a 90% chance to lose $5.

Would you take it?

What if I offered you a lottery ticket that had a 10% chance of winning $100, and a 90% chance of winning nothing. The ticket cost $5.

Would you buy it?

If you’re like most people (in the experiments) you’re much more likely to go for the second bet than the first.

But check the maths again. Those two gambles are exactly the same. They’re just framed in different ways.

In one, there’s the prospect of losing $5. In the other, there no prospect of losing anything, but there is a small expense.

There’s no practical difference, but when the mind is distracted from the prospect of a loss, it takes a more objective view of the bet.

As humans, we just don’t like losing. And we’ll go out of our way (even avoiding favourable gambles) to avoid it. It’s a principal called ‘loss-aversion’ in economics, and if you look for it, you’ll see it everywhere… (insurance, anyone?)

But losses are also a relative concept. If we were talking 7 cents rather than 7 grand, you’d probably feel differently about the bet (though perhaps not about the weird Willy Wonka dude hassling you on the street.)

Or what if I was offering the bet to poor little orphan Annie? What would you recommend? What about if I was offering the bet to David Koch? What then? The perceived weight of the losses changes, and with it, so does the attractiveness of the bet.

Now I’m not saying that there’s anything wrong with being loss adverse. In fact it seems entirely rational, and if you weren’t loss adverse there might be something wrong with your brain.
But as investors, we need to know that our brains are hardwired this way. And we need to be on our guard in case overly focussing on the losses blinds us to some attractive bets.

Now, let’s come back to our bet for 7 and 4 grand. What if I said I was going to run the bet 100 times? Flip the coin 100 times. Then what would you say?

Suddenly this border-line dodgy bet seems like a great deal. Your mind has probably already intuited out the kind of gain you could expect.

100 coin tosses is going to come down somewhere pretty close to 50 heads, 50 tails. The expected value is now $150,000. You’ll definitely lose individual tosses from time to time, but there is a very small chance that you’ll actually lose money over all.

It’s a no brainier. Of course you’ll take the bet. Thanks Willy Wonka dude.

But the odds of any individual bet haven’t changed. Only the number of times the bet is taken.

In my experience, successful investors can do this. They’re able to put their bets in the context of a long series of bets, and this makes them more likely to take the opportunities that arise.

Think about it this way. What kind of returns would you need from an individual property investment? What about if you imagine a lifetime of property investing, maybe over 100 properties? What kind of odds would you need then?

See how it changes?

Of course it’s easier once you actually have 100 properties under your belt. But there’s nothing to stop you thinking like a pro, straight from the get go.

That’s what I do. I approach every investment, not just on it’s individual merits, but as if it were just one of a life times worth of investments (which I know it is).

I know I’m not going to back a golden winner with every investment. But I know if I get a good system in place, over the long run, I’m practically guaranteed to come out way, way ahead.

And certainly more than if my loss-adverse brain kept me on the sidelines.